1 MEED roundtable in collaboration with AIG State of the construction market in the GCC Discussions Finding Report 24 February 2016 Dubai Board Room, Capital Club, DIFC
2 MEED Roundtable, in collaboration with AIG State of the construction market in the GCC Roundtable Host: Stephen D. Riechelman, Head of Client Engagement, Middle East and North Africa Zone, AIG Roundtable Chair: Edward James, Head of Content & Analysis, MEED Projects Report AUTHOR: Colin Foreman, News Editor, MEED GCC Projects Outlook 2016 With oil prices falling rapidly, there is concern over the future outlook of the construction market as governments try to rein in spending. The discussion will focus on the short and long term market outlook, taking into account the oil price, the geo-political environment and the macroeconomic situation. How is the pipeline of project opportunities impacted by lower oil prices? Financings and payment Timely payment and the financing of projects have long been an issue for contractors in the region. How could the environment negatively impact these two issues further? Technical and delivery challenges The current situation could create technical and delivery challenges. How can contractors mitigate these risks?
3 GCC Projects market: 2015 market performance vs January 2015 forecast MEED Forecast GCC Contract Awards vs. actual, 2015 ($bn) Project awards ($bn) 2015 Forecast 2015 Actual Bahrain kuwait oman qatar saudi arabia Source: MEED Projects. Note: forecast is made based on hard data analysis of project pipeline in each country uae gcc Taxation could also cut into margins. In late February, the UAE finance minister confirmed that the UAE will introduce a 5 per cent value-added tax (VAT) on 1 January 2018.
4 Budgeted expenditures largely stable budget expenditures comparison ($BN) saudi arabia oman uae 13.2 kuwait Dubai 12.6 qatar Source: MEED Projects. Kuwait budget runs April-March Dubai is all about salesmanship, it has been for a long time, so when they sell the place they have to deliver, so I can t see it cutting back too much, it is too politically driven.
5 GCC Projects market: 2015 market performance vs January 2015 forecast MEED Forecast for GCC Awards vs actual, 2015 ($bn) Project awards ($m) 40,761 36,513 24,363 22,253 13,451 2,810 Bahrain kuwait oman qatar saudi arabia Source: MEED Projects. Note: forecast is made based on hard data analysis of project pipeline in each country uae UK export credit has been offered for work on airport projects. It is very competitive finance, and I expect more deals like this to help the project move forwards.
6 The AIG Roundtable Good times and bad times are not a new phenomenon for the region s construction sector. Over the past decade it has enjoyed periods of frantic real estate-fueled activity, government largesse with multi-billion dollar infrastructure programmes, as well as endured the global financial crisis and more recently the sharp decline in crude oil prices. Lower oil prices and ongoing political tensions in the broader Middle East region mean the economic outlook for the GCC is weaker than it has been for many years, and this backdrop is dampening prospects for the region s construction sector in The higher level concern in the region is the ongoing geopolitical instability and how that will be aggravated by the slowdown in economies of GCC and how that plays with instability in the broader region, into the Levant and North Africa. Projects outlook For the projects sector, regional projects tracker MEED Projects forecasts a fall of 15 per cent in contract awards in 2016, as lower oil prices affect governments capital investment plans. There are $140bn-worth of contracts that are expected to be awarded this year, compared with $165bn for the whole of Worst hit will be Saudi Arabia. The value of the kingdom s market is predicted to drop by almost a fifth, equal to nearly $10bn, to $40.7bn in The UAE, buoyed by continued spending in the Dubai real estate and infrastructure sectors and long-term strategic spending in the Abu Dhabi oil and gas sector, is forecast to see contract awards fall slightly to $36.5bn from $37.4bn. Dubai s commitment to its long-term vision will ensure spending on projects is maintained despite the worsening financial situation. The third-largest projects market in the GCC will be Kuwait at $24.3bn, down from a record-high $31.5bn in It will be followed by Qatar, which will see contract awards fall by $7bn to $22.2bn. While the two markets will perform worse than last year, their 2016 forecast is still considerably improved on their five-year spending average. Oman and Bahrain are anticipated to maintain last year s spending levels, recording $13.5bn and $2.8bn respectively, although their comparatively small sizes mean this will have a relatively small impact across the region as a whole. On the more positive side, governments know they have to maintain project spending, particularly in social infrastructure, to offset any potential unrest. Social infrastructure Sectors such as affordable housing, education and healthcare are simply too sensitive for states to ignore. Similarly, countries have little choice but to maintain expenditure in critical areas such as utilities, in order to avoid blackouts and other cuts in what are viewed as essential services. The higher level concern in the region is the ongoing geopolitical instability and how that will be aggravated by the slowdown in economies of GCC and how that plays with instability in the broader region, into the Levant and North Africa. Government clients can fund these schemes. They have built up a considerable surplus over the past decade, which they are now using to fund any potential deficits. Other financing solutions, including using private sector financing, export credit, and public-private partnerships (PPPs) to fund schemes, are also being explored, in a sign that states are not prepared to simply see project activity grind to a halt.
7 Despite the ongoing project activity in the market, the financial system is already feeling the strain of lower oil prices and political instability. Revenues of oil exporting countries have fallen resulting in a dip in government deposits at local banks, which has constrained liquidity. The liquidity in the market is the biggest thing affecting construction. Banks are getting a lot tougher on private developers and there is less money flowing through the entire system, and that is the biggest challenge, keeping that liquidity flowing. The problem stems from banks. Financing is coming from the banks and as everyone has said it is the pressure and compression on market, and contractor numbers are growing so everyone is cutting margins, so it is becoming a vicious circle creating more and more cash problems and cash shortages for companies. Tightening liquidity On the more positive side, governments know they have to maintain project spending, particularly in social infrastructure, to offset any potential unrest. Even though banks are committed to local projects, the tightening liquidity is still expected to delay the pipeline of projects that are planned for the region. In Dubai, the slowing property market is producing fewer new opportunities for consultants and contractors. Our biggest challenge for the year ahead and probably two years ahead is pipeline and how long it takes to convert. We always have a fine balance between how we retain our core capability and I work in a business of eternal optimists, and the truth is the pipeline is really healthy, but if that does not move forward for six months to a year then that gives us a really significant pressure, and downstream from that will be margin pressure. Private sector clients developing real estate projects could be the hardest hit when it comes to moving forward with new projects. We feel there will be some reluctance from property developers to move forward with projects. This will affect the pipeline of projects in market so our main concern is replenishing the pipeline. As liquidity tightens banks, regional banks, which are typically governmentcontrolled are restricting their lending to domestic markets to support local projects. Not a single UAE bank is willing to do a cross border financing transaction, even ones that have branches in Saudi Arabia or parts of the Levant or the rest of the region. UAE banks, with exception of one bank are owned by UAE government, so Dubai banks will finance projects, Abu Dhabi banks will tend to look a little further, then you go to northern emirates these smaller banks that are have more appetite for projects, but generally the bigger banks will only finance in UAE. As banks curtail financing, contractors are having to respond. Financing is driving the decisions as to whether we take a project or not. Because the last thing you want to do is take a project and not have the finance. There is one exception for UAE banks as Abu Dhabi continues to support the Egyptian economy. Egypt is different. After the Egyptian political situation with new president coming in, the UAE took a political strategic decision to support Egypt. The government in Abu Dhabi pulled together the business community and told them to invest support and prop up Egyptian government, so I think that it a unique situation. Hydrocarbon prospects Away from real estate contractors expect some oil and gas projects to move ahead together with some infrastructure schemes. I personally believe oil and gas megaprojects will move ahead, but infrastructure, projects not related to Dubai s 2020 Expo and the 2022 Qatar World Cup, will be slow. Not all firms are as positive about the prospects for oil and gas. I work closely in oil and gas sector and what we are definitely seeing in last six months is a slowdown in Abu Dhabi and the ones we thought that were in bag are being pushed back and pushed back and in some cases cancelled. In Oman and Qatar it is almost a case as if Qatar Petroleum is going to sleep now, and nothing is happening in the UAE. In Oman at the moment PDO still saying they will spend what they planned to, but what happens in the next few months will be critical. Kuwait is a market, where we see more activity in the other regions. For infrastructure, Dubai s Expo is expected to move ahead over the next few years. Dubai is all about salesmanship, it has been for a long time, so when they sell the place
8 The liquidity in the market is the biggest thing affecting construction. Banks are getting a lot tougher on private developers and there is less money flowing through the entire system, and that is the biggest challenge, keeping that liquidity flowing. they have to deliver, so I can t see it cutting back too much, it is too politically driven. Unlike 2009 when the debt crisis slowed Dubai s economy to a halt, in 2016 the market is benefiting from its drive to diversify over the past few decades Dubai is not an oil driven market. Developers may slow on real estate as property prices weaken, but the infrastructure work for the Expo will go ahead. The expectations for Dubai contrast with recent experience in Qatar, where the volume of work for the Football s Fifa 2022 World Cup has disappointed as the number of stadiums planned for the event is reduced and non-critical projects such as the Sharq Crossing scheme are delayed. There have been cutbacks for Qatar There is a panic there which you don t see in Dubai. The government has had a knee jerk reaction, they are cutting back staff enormously, so you are left with government departments with a couple of departments. The finance point of view it slows payments. There was 30 people in a finance department there are not 10. The biggest challenge in past 10 years was schooling. A year ago you were battling to get on waiting list, and now the schools are calling to get you kids in. For the smaller markets the headline numbers might appear positive, but they mask the real situation. Firms say there will be one big oil and gas job that changes the numbers significantly, but only one company gets that order and the rest of us are left in the same situation. Saudi concerns Saudi Arabia is the big concern. I have been watching Saudi Arabia closely for six or nine months and it has collapsed, maybe Saudi Arabia is such a big market and things are happening elsewhere, but my experience is there is a standstill in some sectors, clients are not awarding, they are sitting on the fence and waiting. I think the thing that has to go ahead is social infrastructure because they don t want the local population to become dissatisfied. Although many projects have slowed, a lot of work going to local firms that is under the radar. I don t believe Saudi Arabia is going to come to a standstill. Social infrastructure is becoming a focus, and that alone for Saudi Arabia is huge as it can be housing, airports, schools, hospitals, it is the largest country in the region, has the largest population, so it will still be an important amount of work. I believe we are going to see a shift in Saudi Arabia on where they are going to spend, but the volume is still going to be material. The other issue in Saudi Arabia is a stretching of project delivery schedules. Work that has been announced in budgets that will go ahead will be stretched. Projects that were meant to be completed in two years will now take four or five years. In extreme cases work is being suspended. We have actually had jobs we have signed the contract and three minutes later have signed the suspension notice. So those awards, they are not going anywhere fast. With less opportunities ahead, there will heightened levels of competition for contracts that are still advancing. We have concerns in the contracting space. The competitiveness of the market is driving prices down, companies are even accepting to get jobs at a loss just to survive to stay here and survive for better days in the future and this is really the challenge we are facing in the coming days. Competition influx The decline in activity in Saudi Arabia could also see an influx of contractors from the kingdom into the UAE and other markets such as Qatar looking for work. Last year Jeddah-based Saudi Binladin Group secured large orders in Qatar and was understood to be aggressively competing for the contract to build the new terminal building at Bahrain International airport. The unfavorable business environment in Saudi Arabia a few contractors will turn to UAE market so this place will get crowded so completion will increase. Other contractors say there are growing concerns related to liquidity on the projects that have already started. The number one risk is margin pressure, but cash flow and getting paid is also a problem.
9 Another problem that is expected during 2016 is more difficulty securing variation orders from clients that are now struggling for funding. The main challenge we expect this year is the financing of existing projects and clients honouring claims from contractors when there is a change the scope. Clients are stretching their finances and this could impact the delivery of the projects. Tightening liquidity and payment concerns are not a new phenomenon for those that have worked in the region for a long time. I have been in the region for 30 years and it hasn t changed. There has always been pressures on margins, it is just different scales at different times. Over time liquidity evens out as market cycles pass. I am less concerned about liquidity. The reality is when you have been here long enough it is one of the ups and the down and I see it as one of the downs. The downturn highlights a deeper problem that concerns construction companies is the even distribution of profits through the development process. There is something broken in industry for a long time, sharing margin in the value chain. Developers sometimes enjoy margins north of 100 percent and contractors earn single digit, so the idea of sharing risk, sharing pain and sharing gain does not happen in this part of the world. It is an issue of too many contractors on playing field driving prices down taking work on at losses in order to just survive until times get better. The daring designs that clients want in the region further exasperate this problem. Designers and consultants always want to have most tremendous work in region but when it comes to paying for that work there is always a big problem. Unlocking finance The downturn may offer an opportunity for contractors to improve their margins if they can help unlock finance for their clients. If you can bring finance to a project you will generally win the project. For large projects like Al-Maktoum International airport in Dubai, none of the contractors in the region or beyond have the balance sheet to fund something of that size. That is why PPP [public private partnerships] are going to take off. Governments don t have ability to build things they need to build so looking to partner up with private sector. Other funding solutions are also being proposed. UK export credit has been offered for work on airport projects. It is very competitive finance, and I expect more deals like this to help the project move forwards. The ability of export credit agencies (ECAs) to drive projects forward is limited. The ECAs are a small piece of it. ECAs purpose is to promote exports, if they are exporting materials and services and labour, they will finance a piece of it. PPP is a bit different. They are generally 25 ears projects where we share revenue and we get a long term purchase contract for the power plant from UAE government and it is finance by very long term bonds of financial instruments looking for long term investments that are pretty commitment. If you can a 25-year offtake agreement which is a guarantee from government to buy power you will get a lot of people willing to finance it. While the contracting and financial communities may be keen to participate in PPPs experience from the past has shown that the region s governments may be the ones that ultimately lack the drive to proceed. Governments will look at the option of PPP because of their finances they don t have any choice. What We feel there will be some reluctance from property developers to move forward with projects. This will affect the pipeline of projects in market so our main concern is replenishing the pipeline. happens with money that comes from west, and they want to cover risks, and that means they need more from PPP so when it comes to signing with clients the culture that they don t own the asset is a hurdle. This is because for 30 years they haven t needed to give away assets, when it comes to signing on dotted line that is when PPP falls down.
10 Private opportunity More optimistic construction companies view this recalcitrance as an opportunity. What it is going take is contractors that have that vision going forward to put together those deals, and those deals are not financed by banks, but by balance sheets of insurance companies, long term players. What PPP does is bring the resources to meet government s needs, and I think they will be more prone to do it, and we are seeing it in press and government minister taking about it. PPP is a sweet spot for anyone who can pull it off, and those that can are going to earn double digit returns unlike the single digit returns we are all used to. Taxation could also cut into margins. In late February, the UAE finance minister confirmed that the UAE will introduce a 5 per cent value-added tax (VAT) on 1 January Anyone bidding for a contract now will have to put in condition saying and pricing is subject to 5 per cent VAT. The concern is that for ongoing contracts that were priced without allowing for tax could experience issues as clients may opt to delay the new VAT payments or not honour them at all. There will be a lot of grey areas. In our industry ultimately the client will pay for it, and most of the time the client is the government, so the government will be paying themselves. Longer term, VAT and other taxes could change the nature of the GCC s tax free economies. They are starting with VAT, foreign banks are already paying taxes, income tax is being talked about, and they are also talking about real estate taxes. All of these taxes are coming. They will start to tax and it will change the whole model here. Companies will have to adapt as the market transitions into a more mature market. With the private sector expected to play a leading role in the future, there will be new market niches for construction companies. Finance will be the key to unlocking these potential opportunities. Egypt is different. After the Egyptian political situation with new president coming in, the UAE took a political strategic decision to support Egypt. So primarily the government in Abu Dhabi pulled together the business community and told them to invest support and prop up Egyptian government, so I think that it a unique situation.
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